PKN revives as oil prices fall

By bne IntelliNewsApril 8, 2015

Adam Easton in Warsaw -

After years of doom and gloom for European refining, better times have returned on the back of fallen oil prices. Central and Eastern Europe's largest refiner, Poland's PKN Orlen, recorded its highest refining margin for two and a half years in March. However, it remains to be seen if this is more than a temporary upswing.

In what is normally the worst quarter for refiners, the state-controlled company's average refining margin - the difference between the revenue it earns from product sales and the cost of raw materials - soared to $9.40 per barrel in January - March. That is its highest level since September 2012.

Nor is it a one-off. PKN's refining margin has been growing steadily since oil prices buckled in the second half of 2014. In the final quarter, average Brent crude prices fell 29% year-on-year to $77 per barrel, and they currently sit just short of $60. On top of that, a strong US dollar is helping.

"In zloty terms, these are the best times for PKN in its history," Kamil Kliszcz, deputy head of research at M Dom Maklerski, told bne Intellinews. "We think this should be a record high year for PKN's refining business." Last year the company recorded a net loss, not including one-offs, of PLN688mn (€171mn)

Neither is PKN unique. The refining margin at Poland's second largest refiner, Grupa Lotos, has climbed steadily since the second half of 2014.

Turnaround

The results suggest quite a turnaround for Europe's refiners, which appeared to be in the middle of a multi-year downturn because of the economic slowdown, overcapacity and falling margins. In recent years Europe lost much of its traditional gasoline export market because the US has become more self-sufficient. At the same time, new refineries in China and the Middle East are set to start sending their product to Europe.

PKN, which owns Poland's largest refinery in Plock and plants in the Czech Republic and Lithuania, hit rock bottom in January last year. Its average refining margin slumped to negative $0.10/barrel, its lowest level since the company began publishing figures in 2008.

That led PKN to reduce utilisation of its refinery in Mazeikiu, Lithuania, to just over half its 10mn tonne per year capacity. Management warned that the plant - which has struggled with the cost of supplies since Russia shut down the pipeline feeding it shortly after PKN bought it from Yukos in 2006 - may have to close temporarily if the macroeconomic environment did not improve.

On top of the improved margins offered on mainstream output, low crude prices also help refiners earn more from selling fuel oil and bitumen because prices are not directly indexed to oil. Meanwhile, demand for fuel has also been on the rise in Europe and the US. In the final quarter of last year, PKN recorded a 5% year-on-year increase in retail sales.

New cycle?

Some, such as Kliszcz, suggest the rising margins over the last three quarters signal the start of a new trend. "We think we are starting a new cycle in the refining business," he says. "Following the collapse in 2009 we now have a much better demand and supply balance because of refinery closures and increasing demand."

However, not everyone agrees. A source at PKN told bne Intellinews that the recent improved margins are not sustainable, and will more or less halve from their current level.

"We still have overcapacity in the market," he said. "I would expect one or two quarters more and then we will see margins shrinking due to an increase in fuel production. Refineries are running faster now and we will have an oversupply of fuels which will push prices down."

Tomasz Kasowicz, CEE oil and gas analyst for BZ WBK, is another that predicts a temporary upswing rather than fundamental change. He reckons PKN's soaring margin has been caused by strikes and refinery maintenance in the US that have driven up demand for fuel, especially gasoline, from Europe.

"I don't think this is a new cycle. Of course it's easier to generate higher margins when you have crude at $50/barrel, but there have been no structural changes on the European market. Plus the new capacity from the Middle East is hitting Europe and should trim the refining margins," he says.

In May, an additional million barrels of refined product will enter the US market when the refinery maintenance season ends there, he also points out. Margins may remain relatively high through 2015, but will be significantly lower than they are now, he suggests.

That should still benefit PKN's results for the year. Kasowicz estimates up to 60% of the company's operating revenue this year will be generated from the refining segment.

Kliszcz, conversely, suspects the assumptions about overcapacity and the enduring poor refining conditions are exaggerated. "Perhaps there is no spare capacity at the moment," he suggests. "The picture is complicated a bit by the new capacity in China and the Middle East but their access to European markets is not so easy due to restraints on exports."

"A year ago it was easy to explain why margins were low," he says. "After nine months of high margins it's very difficult to explain why they should fall. When I talk to the companies, they say it's not sustainable, but then I ask why and they don't have an answer."

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